The Refining Industry in Crisis... Staggering from the Direct Impact of COVID-19

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[Asia Economy Reporter Hwang Yoon-joo] The oil refining industry is still struggling to escape the quagmire caused by the novel coronavirus disease (COVID-19) crisis. S-Oil, which was the first to announce its earnings, recorded the largest-ever deficit in its history, reaching the trillion-won level. Following this, SK Innovation also posted a loss approaching 2 trillion won. GS Caltex, which has yet to announce its results, is also expected to report a deficit in the several hundred billion won range, putting the oil refining industry at risk of losing the operating profits earned over the past year in just one quarter. The outlook for the second quarter is also bleak. Throughout April, refining margins remained negative, and travel restrictions imposed by various countries due to COVID-19 have yet to be lifted. Although refiners began to actively reduce production this month to manage profitability, there is a strong consensus that results will be as bad as in the first quarter. This is why there are urgent calls for the government to provide substantial support measures for the oil refining industry.

◆ COVID-19-induced Demand Plunge, Oil Price Collapse, and Exchange Rate Woes Compound Troubles = The first quarter of this year was the worst quarter that the four major refiners want to erase. Since the 2008 financial crisis, the largest quarterly operating loss among the four refiners was in Q4 2014 (1.15 trillion won), but the loss in Q1 this year is expected to be more than four times that amount.

In the first quarter, the more products were produced, the greater the losses. The Singapore complex refining margin, an indicator used to gauge refiners' profitability, recorded negative values for seven consecutive weeks from the third week of March to the fifth week of April. The breakeven point (BEP) for refining margins is $4 to $5, and a negative margin means that the price of refined products produced by refiners is cheaper than the crude oil price.

The reason refining margins have not escaped the negative zone is due to a double blow from oversupply (the 'oil price war' among oil-producing countries) and demand reduction (COVID-19). Although production cuts began in earnest this month following agreements among oil-producing countries, demand recovery remains distant. According to the Korea National Oil Corporation, domestic jet fuel consumption in March was 1.13 million barrels, a sharp decline of 65.48% compared to the previous year, marking the lowest level in about 15 years since 2004.

This is due to a drastic reduction in flights as countries worldwide restricted entry and exit to prevent the spread of COVID-19. Consequently, jet fuel inventories are also in a critical state. Both domestic consumption and exports have been hit. Petroleum products and petrochemicals are representative key export items, but in April, petroleum product exports decreased by 56.8% year-on-year, and petrochemical exports fell by 33.6%.

This is because consumption of major export items such as diesel, jet fuel, and gasoline has significantly decreased worldwide. An industry insider said, "We expect the situation to improve in May due to the long holiday, but there are limits to demand recovery," adding, "In the current situation where both domestic and export markets, supply, and demand are unfavorable, it is meaningless to forecast the industry outlook."

◆ "The second quarter is even more frightening" ... The oil refining industry's escape route = The problem lies in the difficulty of recovering earnings in the second quarter. It is hard to create an opportunity to escape the worsening performance, which is the biggest concern for refiners. The CEOs of the four major refiners said at a meeting with the Ministry of Trade, Industry and Energy on the 22nd of last month, "We expect to record losses in the second quarter as well. If profitability does not turn positive from June, the deficit could be larger than in the first quarter."

In response, the oil refining industry began full-scale production cuts this month. SK Energy has lowered its operating rate to 85%, and GS Caltex and S-Oil have advanced their facility maintenance schedules. This decision was made because the sharp decline in petroleum product demand due to COVID-19 made it difficult to manage production.

The government has also introduced support measures, but they are insufficient to find a breakthrough. So far, government support for the refining industry has included expanding strategic oil stock purchases, deferring crude oil import tariffs, temporarily reducing storage facility rental fees, and postponing payment of quality inspection fees to the Korea Petroleum Quality and Distribution Authority for 2 to 3 months. While these measures have somewhat eased the industry's burden, the reality is that anxiety remains high. This is why the refining industry is requesting additional measures, such as reducing the liquefied petroleum gas (LPG) import surcharge and the individual consumption tax on fuel oil for raw materials, which have been subjects of reverse discrimination controversy.

Meanwhile, some expect that with the implementation of production cuts by oil-producing countries from this month and the calming of COVID-19, earnings will improve in the second quarter.

Hyundai Oilbank stated in a conference call, "If oil prices rise as expected, we can achieve breakeven-level performance in the second quarter." SK Innovation also forecasted in a conference call that "the demand deterioration caused by COVID-19 will ease from June."

However, the general analysis is that the scale of production cuts agreed upon by oil-producing countries is insufficient to improve the demand plunge caused by the COVID-19 pandemic. Since refining margins and demand, which are linked to profitability, have not recovered, the industry expects large-scale operating losses to continue in the second quarter.

An industry insider said, "It is fortunate that crude oil production cuts have started in earnest this month and that the recovery from COVID-19 continues," adding, "The key is how much the deficit can be reduced in the second quarter."

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